What is Holdco?
Holdco, also known as a holding company, is an entity that holds a majority stake in subsidiary companies and therefore can exert influence and right to control its business activities. A Holdco may exist solely for the purpose of gaining control over and managing subsidiaries or for conducting business activities along with controlling subsidiaries.
Types of Holdco
The types of holding company are enlisted below:
#1 – Pure
A Holdco that is solely formed for the purpose of acquiring stock in other entities is termed as pure. Such type of a holding company is only engaged in acquiring stock in other companies and does not wish to participate in any other commercial activity.
#2 – Mixed
A holding company that is engaged in the acquisition of stock in other entities as well as performs its business activities are vested with a mixed Holdco status and hence, it is termed as a holding-operating entity.
#3 – Immediate
A holding company that acts as a subsidiary of some other entity is termed as an immediate holding company. Such a Holdco retains control or voting stock of other entities.
#4 – Intermediate
A holding company can be vested with an intermediate status if the same acts as a holding company of one company and a subsidiary of another company.
Example of Holdco
Let’s discuss an example of Holdco.
XYZ Limited recently bought 56 percent shares of AB Corporation Limited and is continuing with its regular trading activities too. Can XYZ Limited be affirmed with the status of a holding company? If yes then what type of a holding company?
Any company can be deferred with the status of a holding company if it acquires more than 50 percent of the shares of a subsidiary. From the above case, it can be seen that XYZ Limited has acquired more than 50 percent shares that is 56 percent share of AB Corporation Limited and hence, the same can be deferred with the status of a holding company. XYZ Limited is a mixed holding company as it continues with its regular trading activities even after gaining control over AB Corporation Limited.
Advantages of Holdco
There are several different advantages of the Holdco are as follows:
- Easy to Form One: Forming a Holdco is really easy. The shares of the proposed subsidiary company can be purchased from the open market without having the need to take approval from its equity holders.
- Large Capital: When a holding company gains control over a subsidiary company then their financial resources are clubbed together and accordingly shown in the financial statements. This enhances the capital for both the parent and its subsidiary company.
- Elimination of Competition: The competition between a parent company and its subsidiary can be eliminated if both of them are the participants of one common industry.
- Maintenance of Secrecy: The authority and decision-making get centralized in a holding company system. Hence, confidentiality does not get impacted at all.
- Avoidance of Risks: The risks and repercussions faced by a subsidiary company will have a negligible impact on the holding company and it can even resell the stakes it has held in the subsidiary as and whenever it feels like.
- Tax Effects: Holding companies that have acquired 80 percent or more of stocks in its subsidiary can file consolidated tax returns and avail tax benefits.
Disadvantages of Holdco
The different limitations and drawbacks of the Holdco include the following:
- Misuse of Power: The members of a Holdco has a financial liability that is completely insignificant as compared to their financial powers. This may either lead to misuse of power or irresponsibility or both.
- Over Capitalization: The pooling of capital of both Holdco and its subsidiaries can even allow a company to suffer from overcapitalization and in such a scenario, the equity holders will not be able to receive a fair return on investment.
- The Exploitation of Subsidiary Companies: The subsidiary companies might be enforced to purchase products and services from the holding company at higher prices. This may also happen that the subsidiaries are compelled to sell their goods to Holdco at a low price. Whatever may be the case is, the exploitation of subsidiaries cannot be denied.
- Secret Monopoly: The creation of secret monopolies will prevent new companies from entering the industry and will take every possible measure to eliminate competition. In such a market, the customers might also be charged unjust prices for goods and services.
Some of the important points of the Holdco include the following:
- For an entity to qualify as a holding company it must hold over 50 percent of the stock (hedge funds, private equity funds, public stocks, etc) in one or more entity or has appointed a majority of the directors for the other company.
- Limited partnerships and limited liability entities are examples of subsidiary companies.
- A subsidiary company whose shares are entirely owned by a holding company is termed as WOS or a wholly-owned subsidiary.
- Establishing Holdco is not only less expensive but also not that legally complicated as compared to a consolidation or merger.
- A holding company is also termed as a parent company.
- The transactions that take place between a holding company and its subsidiary are regarded as related party transactions. These transactions must necessarily comply with all the relevant restrictions that are put on related party transactions.
- Transactions taking place between a holding company and its subsidiary are eligible for stamp duty relaxations.
- The above-stated exemptions are not ordinarily available and the same can be availed only with the help of separate notifications.
A Holdco or a holding company is an entity that purchases and owns shares in one or more entities. This allows the parent company to gain the right to have an influence on its subsidiary company and control its business decisions.
Reasons like tax optimization, ease of formation, large capital, avoidance of competition, asset protection, investment management, etc are sufficient to define why entrepreneurs these days are opting for owning shares in another company instead of a merger or consolidation.
However, there are also disadvantages like misuse of power, exploitation of subsidiaries, over-capitalization, etc associated with holding companies. Therefore, companies must wisely make a choice and carefully handle the rewards and repercussions of the decision of becoming a parent company of a subsidiary company.
This has been a guide to what is Holdco. Here we discuss types of holding companies along with a practical example, advantages and limitations. You can learn more from the following articles –